In my column published last week Friday, I noted that "Interestingly, CNBC reported yesterday that the world's leading investment bank, Goldman Sachs, now appears reluctant to deal with Bear Stearns as a counterparty, a bad sign if there ever was one." During the course of the same day, Bear Stearns, the fifth largest securities firm in the United States, went into a death spiral with shocking rapidity, as the options market signalled its value could be zero.

Only a week ago on Monday, its chief executive, Alan Schwartz, had stated that "Bear Stearns' balance sheet, liquidity and capital remain strong." However, during the course of last week, Bear was subject to the equivalent of a bank run on the company, with Bear's clients withdrawing US $17 billion in only two days. This destroyed its liquidity, which is the life blood of any securities company.

On Sunday evening, after a "shotgun" marriage blessed by the president and Treasury Secretary of the United States, it was announced that JP Morgan had negotiated to buy Bear Stearns for a mere US $2 per share, a fraction of the US$ 36.54 price Bear Stearns had closed on Friday afternoon.
That closing price was itself nearly 50 per cent down from where the company's shares had opened on Friday morning. It is noteworthy that Bear had traded as high as US $158.39 per share only last April.

The sale puts the value of Bear Stearns at a mere US $236 million compared with its previous market value of over US $20 billion.

The question that needs to be asked is why is it that JPMorgan was able to purchase Bear Stearns, a former investment banking powerhouse that was once the biggest underwriter of US mortgage bonds, for far less than the value of its real estate.

Not only does this give a negative value to all Bear's other businesses, but this doesn't even include the value of the New York Fed providing US $30 billion in "non-recourse, back-to-back financing" for the deal.

This appears to have been required by JPMorgan, the second biggest bank in the US, as part of the deal, allowing it to advise its shareholders that it doesn't believe the transaction represents any material risk.

Investors are nervous that other financial heavyweights, such as Lehman Brothers and UBS, will share Bear's fate, although Lehman, unlike Bear, will now be supported by the extension of Fed's liquidity support to the main US securities dealers. The Fed has had to move quickly however to prevent a run on other US banks and securities firms.

The Global Credit Headwinds -Implications for Jamaica

Literally just before the final run on Bear began last week, I spoke with Bear's Head of Emerging Markets Fixed Income Research Dr Carl Ross. As the top analyst on Jamaica (and many other emerging markets) for the company that has raised by far the most money for Jamaica, he was in an unrivalled position to comment on the impact on Jamaica of these events in Wall Street.

Dr Ross is well known in Jamaica, and was clearly extremely shocked by what had happened to Bear in our brief follow on conversation earlier this week on Monday. His comments from last week are still worth noting however.

Unsurprisingly, Dr Ross advised that we are "in a much more difficult international environment than we were six months ago." He noted that Bear's US economics team has just revised their US economic forecast to a recession rather than their former projection of a growth slowdown, based on previous Friday's US employment data. This showed that private sector jobs were falling at a significant rate.
"You've got inflation now, and a very, very weak US economy" said Dr Ross.

In his view, the US is apparently slipping into stagflation (a combination of inflation and low to negative growth), on the back of increased risk aversion, a weak dollar (and higher inflation) and weakening US consumer demand.

Turning to Jamaica, he notes that in common with many countries internationally, we have been severely impacted by inflation. Where this becomes a credit issue for international investors is in the context of the Memorandu of Understanding with the unions. Ross believes that "If foreign investors see wage increases of 15 to 20 per cent, they will take that negatively."

The impact of weak US consumer demand on demand for Jamaica's goods and services was ambiguous in Ross's view. "We've seen very strong tourism flows in the first two months. It appears that Europe and Canada may be offsetting a weak US. The addition of new and updated hotel rooms provides a very strong underpinning in that sector."

Commenting on the new US $200 billion Fed facility for the banks, just before the fed extended a similar deal to the security dealers, Dr. Ross noted "The credit markets are seized up - they are not functioning. The Federal Reserve can cut interest rates all it wants, but if credit markets are not functioning it will have no effect. So we see this new liquidity facility as the Fed trying to increase the effectiveness of monetary policy, so that when they do cut rates it has some impact."

The Fed intended to lend the money to financial institutions for a term of 28 days, rather than the normal overnight loan, in a coordinated action with central banks in other countries to reduce the impact of an emerging global credit crunch. It has now put in place additional measures to cover the security dealers, including a most unusual Sunday cut in the discount rate for banks, a most telling indication of the level of financial distress.

Emerging markets such as Jamaica's have not been spared from the carnage. Dr Ross notes that "Debt issuance from emerging market has collapsed from the first two months of last year. Investors don't want to buy, and issuers don't want to issue, at these higher spreads and yields".

The risk aversion in the international capital markets has direct implications for Jamaica. It will be "very, very difficult for Jamaica to access the international capital market", says Dr Ross. The news is not altogether bad, as Dr Ross notes that there is still time as "it not like Jamaica has to access the international capital market in the near term".

Oppenheimer's Greg Fisher (formerly of Bear Stearns), who has probably single handedly traded more Jamaican bonds than anybody else, in a presentation in Jamaica a week ago Saturday also noted that now would be a bad time for Jamaica to try to do a bond issue.

As he was speaking before the collapse of Bear last week, he would doubtless be even more strident in this view now.
Nevertheless, Fisher also believes that Jamaica can "muddle through the global recession", arguing that our situation is still favourable relative to his memories of the "perfect storm" here three to four years ago.

He noted, however, that local financial institutions should become more cautious in their use of borrowed margin to finance their international Jamaican Eurobond portfolio's. Fisher's main concern, in common with our Prime Minister Bruce Golding, is the effect of rising oil prices on Jamaica's economy.

In an update earlier this week, I asked him if he was concerned about the effect of the collapse of Bear on the outstanding margin to buy Jamaican bonds. Fisher commented:"I don't think there is much emerging market margin exposure...Exposure is more with Structured Products done as Bear as issuer.

But Jamaica is far less exposed than the rest of the Caribbean or Central America."

Fisher is clearly correct, as the near dominant franchise Bear had in the buying and selling of Jamaica's debt has substantially eroded, not least because he himself took a lot of that business with him when he went to Oppenheimer.

The reduction in Bear's client base, combined with the more cautious approach of new firms such as Oppenheimer in providing margin to Jamaica, make a 2003 scenario of widespread margin calls leading to a collapse in our bond prices much less likely than before.

Moreover, over the past five years, local money market players have grown their balance sheets much more slowly than in the five year period just before the "perfect storm" of 2003.

In addition, our local money market players have also been raising a very substantial amount of capital by way of preference shares over the past few months, substantially reducing their financing vulnerability. While they may have advertised this capital raising as for new opportunities, this move will also allow them to meet tougher regulatory requirements, and may thus prove to have been extremely timely. Additionally, all the major players are now quoted, with their relatively simple balance sheets making them quite transparent, so there is currently no reason for the type of confidence issues that are currently besieging Wall Street, or to which we were exposed in Jamaica in 2003.

Nevertheless, it is likely that Jamaica will continue to be affected by the negative situation internationally. Jamaica will require extremely good management and a collaborative approach to weather this challenging situation.

Trousers in Denim

Cream of the 'Crop'

Cheeky's World